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Posted 1/12/2004
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| | Contrarian Chronicles
If 2004 goes bad, it will go really bad
The dollars decline is going to cause huge problems, and the economy is artificially pumped up. When the deluge finally hits, I see stocks falling 50%.
By Bill Fleckenstein
With this, the first Contrarian Chronicles of 2004, I want to sketch out a roadmap of how I think events might play out this year.
It's been my experience that having an opinion (and strategy) for what you think may occur will help you to manage your portfolio. Of course, that strategy needs to be tweaked as new data come in.
My opinion is mostly a carry-through from last year. I continue to believe that the stock market, currency market and economy are basically all the same trade, and that the environment in which we live is as binary as any that's ever existed. That is, the markets up and everyone is partying or down and all hell has broken loose.
Why do I think this? We have folks running the Fed (and the Treasury, for that matter) who are the most incompetent and irresponsible of all time. That's old news, but what's new, in my opinion, is their full-blown display of arrogance. They talk about keeping interest rates low indefinitely, while paying lip service to deflation or disinflation, when the opposite is happening in nearly every commodity market. (Editors note: The Commodity Research Bureau index is up about a third since last March.)
They shrug off the decline in the dollar when it's the world's reserve currency (and no longer a monopoly). The Fed and other bulls take foreigners' dollar appetite for granted, in terms of funding our huge current-account deficit, even as our macro position is horrible vis-a-vis our unfunded future liabilities, total debt outstanding and budget deficit.
Oh, those back-slapping central bankers
The fact that the "authorities" were able to produce a sizable stock market rally last year and a strong third-quarter GDP has prompted them to do a little end-zone dancing. Chairman Alan Greenspan's recent talk at the American Economics Association meeting in California was all about declaring victory. In as many words, he said, "So what if I created a bubble and didn't pop it? The recession was painless, and I've orchestrated the next recovery." It's kind of like a kid taunting na-na-na-na-na.
That has further fueled the Fed's arrogance in maintaining that the dollar's collapse doesn't matter. Though it will come to matter, the fact that it has not thus far has emboldened the Fed to believe in its own omnipotence. Once convinced it knew the future, the Fed now appears to realize that it might not know the future, but that doesn't matter, since it thinks it can fix anything. The Fed believes it can make the economy and the stock market do whatever it wants (though I'm sure it had its doubts for a while). Likewise, the Fed believes itself powerful enough to fix the currency market whenever it deems that necessary.
Make no mistake. The Fed does not have this power. Add to this the fact, first, that the "money-management business" (with its plethora of mutual funds, investment counseling firms, and hedge funds) has so many practitioners who've grown up in an era where it's all been about marketing and not risk management, and second, the fact that we have a public that wants to believe it will all be okay -- and you have a recipe for what we now have, which, to repeat, is an incredibly binary situation.
Slam-dunking toward disaster
The Fed, the money-management industry and the public, to some degree, are all in. Folks are either leveraged to the hilt in housing or real estate investments, and/or they are piling into stocks. In both cases, the rationalization is some variation of the greater-fool theory. It's being powered by all the liquidity spewing forth from the Fed, combined with the debt that's been created by the financial system, not least of which comes from the government-sponsored entities Freddie (Mac) and Fannie (Mae). So, we continue to build a bigger and bigger balsawood edifice, which is the current state of our financial markets. And we have this giant anvil dangling from dental floss above the balsawood structure, with the anvil being our burgeoning debt and collapsing currency.
The outcome of this whole tragedy to me is quite clear: I believe that stocks will at some point collapse. Fixed income in all likelihood (though this is less clear to me) will get shredded, thanks to what's going on in the dollar. The dollar will be further bludgeoned, and, I think, metals will go to places we can't even conceive of. What I do not know is the timing of all that. When will stocks start going down? When will the currency decline matter to the fixed-income market? When will the metals really go crazy?
Price as barrier to re-entry
I came into this year with no shorts and just my long positions in metals, metals stocks and Annaly Mortgage (NLY, news, msgs). Regrettably, I had reduced my position in foreign currencies before going away on vacation. They are all up smartly, so I have been left a little behind on that trade. I did the same with respect to my trading position in the precious metals. So, while I have the full complement of my position in Newmont Mining (NEM, news, msgs) and Pan American Silver (PAAS, news, msgs) (the latter of which I am a director), my trading positions in foreign currencies and precious metals have been reduced. With prices having gone basically straight up, it's been hard to add to these trading positions. I am currently wrestling with how much of the present action in these markets is a function of new money, a bit of a mini-blowoff to this piece of the move, or just the start of acceleration to a mini-blowoff.
In order of imperativeness, I am much more eager to expand my position in precious metals and currencies (though my personal stock position in Pan American and Newmont is quite sizable), than I am to get short stocks. As has been the case, I think we'll be making plenty of money being long currencies and precious metals before we make money being short stocks. I've done nothing basically because the environment is so binary (and all these trades are different expressions of the same view) that I feel no compunction to rush into anything, especially in the shorting-stocks department.
I would rather be late to that party than early, since it's so clear to me that when stocks go down next time, they're going to go down for real. I anticipate that we will see a huge decline, with the major averages falling over 50%.
Ferreting out before forging ahead
Though I feel that I know how this movie ends, I don't know quite where we are and what action to take yet. (That's another big reason for my inaction over the last few weeks). I am searching for clues as to what to do in all those markets, and I will share with readers what I think and do once I arrive at a conclusion. Of course, there's no guarantee that I will be right. But for what it's worth, this is my roadmap and strategy for the year that's all of two weeks old.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com site. His investment positions can change at any time. At the time of publication, he held long positions in Annaly Mortgage, Newmont Mining, and Pan American Silver. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money.
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